Notes From Underground: Trichet, Juncker, Papandreou, Sarkozy and Merkel Provide the Dance of the Seven Veils

Another weekend full of “surprises” as the EU tried to entrance the markets with the slow dance of default/reprofiling/insolvency/bailouts/bail-ins/austerity budgets and of course a voluntary agreement to reschedule the duration of the debt of the PIIGS. No matter if you put a veil on it: a PIG is a PIG. The language of the Eurocrats is so convoluted that every press release creates more confusion rather than offering any type of clarification of how the financial support mechanism is to provide support in real terms. In seems that the Brussels Eurocrats are mainly concerned about the banks and how much exposure they have to a Greek default. A major credit event in Greece will cause the other PERIPHERALS to consider the possibility of a “default” in response to a major solvency action by the Greek authorities.

The most important element is, HOW MUCH OUTSTANDING EXPOSURE DO THE BANKS HAVE TO THE CREDIT DEFAULT SWAPS? Remember this term and keep it close at hand: EMPTY CREDITOR. The term empty creditor is a European euphemism for speculator and it denotes the idea that an “investor” has bought a CDS on a sovereign debt instrument but does not actually own any of the actual bonds, thus there is no hedge; just a position on the possibility of a country’s default. Under law, the CDS owner is supposed to be paid if there is a default, but the banks seem to have sold so much CDS on the debt of the PIIGS that there is a systemic risk element involved. If the political powers can find a way to alleviate the positions of the “EMPTY CREDITORS” then Greece would be able to reschedule it debts and do its “VOLUNTARY “ workout with its lenders.

With every new dance, a veil is removed and we will find that the European Enchantress is left standing naked. Usually lies and obfuscation in financial markets breeds contempt. Unfortunately, in Europe it seems to breed familiarity and complacency. It seems that the euro rally today was aided by a statement from Klaus Regling, head of the EFSF, in which he let it be known that the EFSF would increase its available funds for bailouts and guarantees of European sovereign debt.

The most important data release this week will be the FOMC STATEMENT and then two hours after the release will be Chairman Bernanke’s second press conference. In my opinion, the most important piece will be whether the FED is maintaining its extended period language because of the GREAT UNCERTAINTY EVOLVING FROM THE EUROPEAN DEBT CRISIS. Mr.Bernanke has been quiet on the European crisis so it will be of great interest to hear if rising concerns about Greece are causing the FED to rethink its removal of stimulus. In a Bloomberg piece by Rich Miller, “Self-Induced Paralysis,” the article picks up on the speech I alluded to last week that Bernanke delivered to the Japanese in January 2000.

The article probes the idea that the recent weakness in the U.S. and global economies is possibly putting the FED into a position of paralysis. One criticism of the FED is leveled by Bernanke’s academic colleague, Alan Blinder, who maintains that the FED is too passive for the current economic conditions. Professor Blinder suggests that the FED need not have another QUANTITATIVE EASE but rather lower the IOER to ZERO or maybe go negative, placing a tax on the reserves that U.S. Banks hold at the FEDERAL RESERVE.

The INTEREST ON EXCESS RESERVES(IOER) has been one of the tools that the FOMC has discussed in its ability to begin the removal of liquidity from the system. Now Alan Blinder is suggesting that the FED force banks into credit creation by removing the incentives to hold reserves for a mere 25 basis points. The Blinder recommendation just amplifies the uncertainty that exists among those who purportedly are the advisors to the policy makers. All of this dissonance leaves investors in search of assets with a modicum of certainty. Even the euro can find a reason to rally when compared to the uncertainty in the U.S. The DOLLAR may need one of those veils to hide it lack of attractiveness. Oh well, a weaker DOLLAR should help remove some of the FED‘s perceived paralysis.

5 Responses to “Notes From Underground: Trichet, Juncker, Papandreou, Sarkozy and Merkel Provide the Dance of the Seven Veils”

As they sang in Porgy and Bess—It Ain’t necessarily so.As Blinder and others will be opining about,there are other mechanisms.Dust off the Fed’s playbook and we will wait to hear the press conference tomorrow to see if ther are any hints,but to onlyfocus on QE3 may make us miss something more significant.

In Bernanke’s oft-quoted work Monetary Policy Alternatives at the Zero Bound he describes several methods for creating inflation. Buying on the long end of the curve, outright asset purchases, or buying of foreign currencies are all touted as alternatives to only controlling the short end of the curve. One of these or a combination of them is certainly on the horizon. There is no doubt that it will be of a different structure than the current $600 billion bond purchase program. To repeat any strategy already used would be to tacitly admit failure and we can’t have that. Confidence in The Fed is already shaky.